Brazil's recent foray into local-currency international bond offerings was a misjudgment by all concerned. Emerging-market countries should certainly take full advantage of their new-found ability to issue debt abroad in their domestic currencies. But in some cases, just because you can do so doesn't mean you should.
Brazil is one such country. It issued a R3.4 billion ($1.5 billion) 10-year Eurobond in September, yielding 12.5%. Despite a huge amount of hype, the issue performed badly in the aftermarket: investors that bought in at launch were soon hurting, and Brazil did nothing to bolster its spotty reputation in the primary debt capital markets.
Many of the investors were hedge funds that had been expecting the bond for some time. That gave them the opportunity to sell short the Brazilian domestic curve in advance of buying the new long-dated paper. In stark contrast to similar deals out of Colombia, yields on domestic Brazilian debt actually went up as a result of the issue, not down.
Brazilian institutions were also important buyers of the bond. Local investors pay income tax on Brazilian bond coupons, but Eurobonds are tax-exempt. Brazil therefore lost the effective 20% discount that it gets on all local bond issuance. Once again, the contrast with Colombia is stark. That country lowered its borrowing costs by issuing abroad. Not Brazil.
And the deal will only ever make fiscal sense for Brazil if inflation skyrockets – it's essentially a bet against the efficacy of the country's own central bank. A massive devaluation of a freely floating currency, especially one that persists over many years, only happens in the face of rising inflation.
Brazil did get a valuable data point regarding its domestic yield curve. Since no domestic debt goes out anywhere near 10 years, it's good to know where the market values such paper. But this data point is much less useful than the ones generated by Brazil's broad and deep domestic capital markets.
Brazil would have been much better served slowly pushing out its domestic curve, and reducing the barriers that have kept international investors out of that market. At the moment, foreign investors interested in Brazilian domestic debt usually end up buying synthetic instruments on Wall Street rather than brave the thicket of taxes and regulations facing them in São Paulo.
Brazil is a country the size of a continent, and foreign investors will flock there given the remotest opportunity. That's an enormous advantage that Brazil has over such countries as Uruguay and Colombia, which will always have difficulty persuading foreign portfolio investors to register as participants in their domestic capital markets.
Brazil, then, should have followed the lead of Mexico rather than that of Colombia. Mexico has more foreign participation in its local-currency debt than any other Latin country, but it has never issued a peso-denominated Eurobond. As a result, Mexico has now reached the point where long-dated mortgages are being written in nominal pesos. That will never happen in Brazil so long as the country insists on going abroad for its long-dated domestic-currency issuance.